Zinc Backwardation Widest Since 1997 With Inventories Lowest Level in Over 25 Years

More turmoil in the metals markets, backwardation in zinc stretched to the widest since 1997. That is the premium for spot zinc over futures spiked on Thursday to the 25 plus levels. The move comes from a supply squeeze after inventories slumped this week to the lowest level in at least 25 years. It was only three months ago an unprecedented short squeeze occurred in the nickel market, the LME said it’s monitoring the situation closely.

Zinc Ingots

LME suspended nickel trading after Nickel prices roughly doubled to all-time highs, up 500% from Friday. Nickel soared over $100,000 a ton to an all-time high on the London Metal Exchange when prices surged around $40,000 in just one hour. The move came from a short squeeze with a major Chinese bank where a unit of China Construction Bank Corp. got extra time to pay hundreds of millions of dollars in margin calls.

The LME has since introduced several emergency measures designed to prevent short squeezes from running out of control Despite this the reality is the historic backwardation in zinc could still mean huge losses for buyers who need physical metal now. One of the LME’s recent measures was to allow short position holders to defer delivery, but they still have to pay a penalty.

“We note stock withdrawals in the zinc market, and are monitoring this closely,” LME spokeswoman Miriam Heywood said by email. “We have implemented a number of additional controls on LME metals to address a low stock environment — including a backwardation limit and deferred delivery mechanism — which are designed to ensure continued market orderliness.”

LME zinc inventories have been depleted almost entirely in both the U.S. and Europe, which has elevated to withdraw the remaining stock in Asian depots. Readily available zinc stockpiles on Thursday fell to 19,825 tons which is equal to about half a day’s worth of global consumption.

There is often confusion between spot prices and spreads. Three-month zinc prices fell 1.6% on Thursday, however the spread between spot contracts and futures spiked dramatically with the collapse in inventories. Cash zinc contracts surged to a premium of $199.85 a ton over three-month futures on Thursday.

The spread between contracts expiring tomorrow and those maturing a day later also spiked to $100 a ton, the highest level on record in data going back to 1998. However, the new 1% daily backwardation limit on the spread means that the trades will be reset in line with the maximum level Bloomberg reported.

The cash spot left investors and industrial hedgers with expiring short positions with few sellers to turn to as they looked to buy their contracts back. In reality this is also poor risk management with traders hoping to get a cheaper roll or make money on the settle. Futures market that avoids this give a roll date mandatory that is not so close to settlement.

The last time spreads were this wide, in 1997, Chinese traders accused Glencore Plc of distorting the market by driving down LME inventory levels. The company denied the allegation. Interesting the Nickel squeeze involved Chinese players.

In April this year, Bloomberg reported that Trafigura Group had been withdrawing significant volumes of zinc from London Metal Exchange warehouses to make up for a shortfall in its own supplies after production cuts in Europe. The company’s Nyrstar unit has reduced production at zinc smelters in Europe in response to ballooning power costs.

Source: Bloomberg

From The Traders Community News Desk